Do Most Companies Even Try to Innovate Anymore?

Executive Summary

We are living in the age of the superstar firm. Several explanations have been proposed for the emergence of this “winner takes most” competition: a drop in search and transaction costs because of the Internet; network effects; the ability to scale up quickly due to IT and automation. My analysis suggests another driver: R&D investment is increasingly concentrated in a few top firms. Some firms are investing heavily in R&D to expand their technological capabilities, while others don’t make that investment and fall further behind.

We are living in the age of the superstar firm. Companies like Samsung, Google, or BMW—the top players in their respective industries—are prospering. Yet economic growth remains sluggish in many parts of the world. The reason for that paradox, as the OECD has warned, is that the productivity gap between firms at the global frontier and those lagging behind has widened. Frontier firms are able to employ the most advanced technologies, which in turn allow them to win market share at the expense of their less productive competitors. And the globalized markets that frontier firms operate in disproportionately reward their knowledge advantage, setting them even further apart from the rest.

In a recent Harvard Business Review article, Nicholas Bloom from Stanford University argued that this type of “winner takes most” competition is an important driver of rising income inequality. The Google’s of the world, in their global hunt for talent, are extremely generous when it comes to employees’ salaries. Meanwhile, wages are stagnating for many workers at less successful firms.

Several explanations have been proposed for the emergence of this “winner takes most” competition: a drop in search and transaction costs because of the Internet; network effects; the ability to scale up quickly due to IT and automation.

My analysis suggests another driver: R&D investment is increasingly concentrated in a few top firms. Some firms are investing heavily in R&D to expand their technological capabilities, while others don’t make that investment and so fall further behind. I believe this could be one of the main reasons for the widening productivity gap we observe.

Take the example of Germany: Between 2003 and 2015, R&D expenditure in the business sector increased by 59%, reaching a record high of 157.4 billion euro. Over the same period, however, the share of firms in the economy investing in R&D fell from 47% to 35%. In particular, small and medium-sized enterprises reduced their innovation efforts. So even as R&D expenditure has risen, it has become more and more concentrated within a smaller share of firms. The Gini coefficient—a commonly used measure of inequality—has been increasing steadily in Germany since the mid-1990s.

Whether the same thing is happening in other countries remains an ongoing research question. More often than not, researchers are constrained by the lack of good data sources. Nonetheless, U.S. data show something similar. Overall, business R&D increased by 67% between 2003 and 2014. And the increase was largest for the firms investing the most. In 2014, the hundred U.S. companies with the largest R&D budgets invested 92% more in innovation than in 2003. And the gap between how much large firms spend on R&D compared to smaller ones has exhibited a noticeable upswing since 2009. Moreover, recent research suggests that nowadays basic research activities are more concentrated in more specialized firms than it was the case several decades ago.

It’s unrealistic to expect every firm to invest in R&D. Yet, the concentration of this crucial activity is quite concerning. A higher concentration of innovation efforts can be a major source of productivity differences between firms, and economists, policy makers, and business leaders should pay close attention to these trends. Competition at the global research frontier is getting more and more fierce. At the same time, many firms seem to be unable to keep up with the pace at which this development is unfolding. Those left standing become the superstar firms. The rest get left behind.

Paul Hünermund is a PhD student at KU Leuven in Belgium and in September 2017 will start as an assistant professor at Maastricht University in the Netherlands.